Oil: Riyadh Trumped!

Summary: Saudi Arabia heads into the Vienna OPEC meeting facing stiff headwinds in its bid to secure a higher price for oil.

We are again grateful to Alastair Newton for the article below. He worked as a professional political analyst in the City of London from 2005 to 2015. Before that he spent 20 years as a career diplomat with the British Diplomatic Service.

Three things appear clear about the OPEC ministerial meeting in Vienna on 5 December and the meeting of the so called OPEC+ group the following day.

First, Saudi Arabia is looking for an outcome which will push the price of crude higher without the Kingdom being forced to continue to pump below its quota in order to compensate for other OPEC members’ (Iraq, Nigeria) non-compliance with the reduced quotas agreed in December of last year.  That agreement, which was extended by nine months when OPEC+ met in July, is supposed to take 1.2 million barrels per day (bpd) off the market until the end of March 2020 when it is due to expire. Despite this, except for just very brief periods (most notably, the few days after the 14 September attacks on Saudi Aramco’s installations), the price of benchmark Brent crude has remained closer to USD60 per barrel (pb) than USD70pb since it fell off its year-high of USD74.57pb in April. Worse still, if Opec were to maintain into next year output at the level of last month, i.e. 29.7mbpd (despite an unintended reduction of 120,000bpd relative to October’s production), the organisation itself is forecasting a surplus in the market of 650,000bpd for the first half of 2020.

It is not surprising, therefore, that OPEC+ is reportedly considering an additional cut in output of 400,000bpd. Despite other signs that such a cut in output is not on the cards, these reports did send Brent higher at the start of the week — albeit only to USD61.28pb and, even then, only briefly.

Second, that 400,000bpd figure is more or less the same as the current total overproduction of the OPEC+ group relative to the quotas agreed in December 2018. Thus, the real issue may not be agreeing a further cut as such but trying to enforce better compliance with existing quotas. All the signs are that Riyadh will push particularly hard on non-compliance, which is only to be expected given that Saudi Arabia has been producing below its quota for most of this year to compensate for others’ dereliction.

However, it seems very likely that the Saudis will run slap into a counter-argument from Russia, itself non-compliant, in the form of a bid to have condensate (ie light crude which is a byproduct of natural gas and 6% of Russia’s total production) excluded from the way in which its output is calculated. As condensate production is not taken into account for OPEC members’ quotas, Russia does have a case; and it is likely to find support from at least one other non-OPEC member, i.e. Kazakhstan which is also a major condensate producer and which is therefore similarly placed. This accounting disparity will likely greatly complicate reaching the sort of agreement for which Saudi Arabia seems to be looking. Thus, it should be no surprise if Riyadh has to settle for no more than a further extension of the 1.2mbpd cut agreed 12 months ago plus more fine words on compliance which may or may not prove to be worth the paper on which they are written.

Third, as the past 36 hours or so have readily underlined, even if OPEC+ does manage to reach —— and stick to — a substantive agreement on further cuts/compliance with existing ones, any consequent upward pressure on the oil price may be undone by US President Donald Trump’s trade-related words and deeds. From the perspective of the investment community, Mr Trump — coupled with a global economic slowdown which many economists believe would be underway in any case — has been a major factor in determining the price of crude for most of this year.  This week has been typical, as the oil price softened after its early uptick thanks to the reimposition of US steel and aluminium tariffs against Argentina and Brazil, the threat of hefty US tariffs on imports from France in retaliation for the latter’s digital services tax and the US President’s mulling that a trade deal with China might have to wait until after the 3 November US general election.

This being said, a majority of investors probably see the latter as ‘classic’ Trump negotiating tactics and believe that we will still see a modest China/US ‘phase one’ trade deal early in 2020 (if only because the consequences to the US economy — and therefore Mr Trump’s prospects for re-election — of the tariffs on consumer goods which are currently due to come in on 15 December would be very negative). However, the US President’s obsession with bilateral trade deficits and clear penchant for deploying tariffs (and other economic sanctions) to try to enforce Washington’s will generally are likely to continue to have a negative impact through 2020 not only on market sentiment but also on the real economy and, therefore, the rate of growth of demand for oil.

It is possible, of course, that Mr Trump’s stance on Iran could yet push oil in the opposite direction, i.e. by precipitating major military action in the Gulf region. But this too tends to confirm that, for at least the next 12 months or so, decisions made in Washington will very likely weigh considerably more heavily on the price of oil than whatever is agreed in Vienna over the coming two days.

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